Is all the hoopla about malpractice costs just a red herring? When the topic of health care reform is brought up, the discussion often includes the burdensome costs of malpractice insurance and jury awards, the strain that lawsuits put on our court system and the incessant fear that doctors have about being sued. But when it comes to reducing costs, few people ask which of these items are actual material. Let’s start with the second two. First, it is not hard to imagine that thousands of malpractice lawsuits take up an inordinate amount of time and court resources. I have no idea how many are frivolous or brought about by ambulance chasers, but my guess is there is a way to both speed up the process and save on costs through prudential reform. Next, from what I hear from my friends who are doctors, the fear of a malpractice suits unequivocally leads to the administration of more services. No resident or doctor wants to get sued because he or she did not order the correct precautionary tests or procedures. So in that way there is no question that potential lawsuits add costs to the system. But what about the costs of insurance and jury awards? How big a percentage of total costs do these represent? According to this article in the NY Times, very little:
The direct costs of malpractice lawsuits — jury awards, settlements and the like — are such a minuscule part of health spending that they barely merit discussion, economists say. But that doesn’t mean the malpractice system is working.
The fear of lawsuits among doctors does seem to lead to a noticeable amount of wasteful treatment. Amitabh Chandra — a Harvard economist whose research is cited by both the American Medical Association and the trial lawyers’ association — says $60 billion a year, or about 3 percent of overall medical spending, is a reasonable upper-end estimate. If a new policy could eliminate close to that much waste without causing other problems, it would be a no-brainer.
At the same time, though, the current system appears to treat actual malpractice too lightly. Trials may get a lot of attention, but they are the exception. Far more common are errors that never lead to any action.
All told, jury awards, settlements and administrative costs — which, by definition, are similar to the combined cost of insurance — add up to less than $10 billion a year. This equals less than one-half of a percentage point of medical spending. There have been years when malpractice payouts rose sharply, but there have also been years when they did not. Over the last two decades, the amount has increased roughly in line with total medical spending, according to a study in the journal Health Affairs, based on a national database...
The problem is that just about every incentive in our medical system is to do more. Most patients have no idea how much their care costs. Doctors are generally paid more when they do more. And, indeed, extra tests and procedures can help protect them from lawsuits.
The article clearly tackles a number of subjects that I think are very relevant. The first is that of malpractice costs. Not that $10B is small potatoes but in the grand scheme of total spending it is a tiny drop in the bucket. The estimates of the costs of wasteful treatment are about 6 times as large but even when combined, $70B is a fraction of total spending. I’m not saying that the incentives and costs created by the specter of malpractice suits could not be affected positively by reform. I am just trying to point out that this is only one aspect of the system that needs an overhaul, the most important of which is addressed in the last paragraph above. Doctors are incentivized to offer more services and most patients have no reason to dissuade doctors because they never see the cost. This dynamic is exactly what needs to be altered if we have any chance of reducing spending on health care and our ballooning national deficit.
Too big to fail= too big to exist: Thanks to Karl Denninger for posting these comments from former S&L regulator Bill Black regarding too big to fail institutions. I’m not sure I have seen a more succinct and articulate synthesis of the problem these behemoths pose. I think he properly identifies the real problem (which we know Simon Johnson agrees with): the bigger these companies get the more powerful they are politically. How is it that you think our regulators and politicians got so captured by the financial system participants? It’s a very similar situation to the one in which a single customer owes the bank a ton of money. If you owe the bank $100K, the bank owns you. But if you owe the bank $100M, you own the bank in the sense that your failure can bring down the bank as well. In the case of the TBTFs, they got so big that they could not be wound down in an orderly fashion and had so many assets and liabilities that they in effect owned the system and the regulators. Needless to say, if we are to avoid further financial crises, the standing of these institutions must be reduced substantially. Here are Black’s comments:
The Treasury has fundamentally mischaracterized the nature of institutions it deems “too big to fail.” These institutions are not massive because greater size brings efficiency. They are massive because size brings market and political power. Their size makes them inefficient and dangerous.
Under the current regulatory system banks that are too big to fail pose a clear and present danger to the economy. They are not national assets. A bank that is too big to fail is too big to operate safely and too big to regulate. It poses a systemic risk. These banks are not “systemically important”, they are “systemically dangerous.” They are ticking time bombs – except that many of them have already exploded.
We need to comply with the Prompt Corrective Action law. Any institution that the administration deems “too big to fail” should be placed on a public list of “systemically dangerous institutions” (SDIs). SDIs should be subject to regulatory and tax incentives to shrink to a size where they are no longer too big to fail, manage, and regulate. No single financial entity should be permitted to become, or remain, so large that it poses a systemic risk.
I like that: SDIs. Reminds me of an STD. Anyway, Black also goes on to present some rules and limitations for these companies that include not being able to acquire other firms or grow, higher taxes proportional to size, multiple examinations and audits on a regular basis, leverage limits and higher capital requirements. In other words, he wants what would be revolutionary reform that would leave the TBTFs looking nothing like they do now. Unfortunately, based on the strength of their lobby and size of their political contributions, such dramatic change is quite unlikely. However, in a perfect world in which we could start all over again, Black’s common sense proposals would create a very safe and secure foundation for our financial system. Too bad the oligarchs, banksters and manipulators would probably intentionally crash the entire global system before they let such reforms pass.
A former sell side analyst who called the crisis? Hat tip to Zero Hedge for posting the link to this interview with Josh Rosner, a former sell side guy who apparently warned of the impending financial crisis. This is a VERY good interview and I suggest you read it in its entirety. What I want to highlight is first his commentary on the conflicts of interest that plague the sell side equity research analysts:
Damien: What exactly has you diverging toward the independent analyst route?
Josh: One is the most obvious potential conflicts of interest between investment banking clients and research — right where perhaps analysts puts a more favorable spin on the securities of companies they’ve got a banking relationship with. Furthermore, the willingness to be pressured by large institutional clients who want you to consider stocks or securities that they’ve got heavy exposure to.
It seems to me that the independence of your view is really paramount. In the largest and most complex financial institutions, the institutions themselves do not offer levels of disclosure and transparency that make them truly analyzable.
Damien: Is it hard to get access because you don’t play the game?
Josh: I have to rely solely on the cold hard facts of their filings and public disclosures coupled with my macro-economic analysis. Wall Street is so soiled it becomes hard for an analyst at a traditional Wall Street firm to actually have an economic outlook. The guy who’s covering the mortgage bankers is not covering the mortgage insurers. The guy who’s covering the mortgage insurers is not covering the GSEs. The guy who’s covering the GSEs is not covering the thrifts. However, changes within a sector occur where all of these sub-sectors meet. So, the traditional sell-side analyst is stuck relying much more heavily on management to give them macro guidance and highlight structural changes in the industry. Consequently, their independence ends up jeopardized.
One of my criticisms of the sell side research industry is that the analysts are put into their own silos that force them only to focus on the companies they specifically cover. Accordingly, they have trouble seeing the forest through the trees and often have no sense of how broader macro factors can affect their coverage universe. Plus, you have the additional bias created when the company also provides investment banking services to a firm on an analyst’s coverage list. If you believe that there is a Chinese wall that actually reduces any conflict of interest then you might as well spend your time searching for the end of the rainbow for that infamous pot of gold.
Finally, what I really liked about this interview is that Rosner also gives us some of his insight on the macro environment and the financial system. The two takeaways are that the collapse of the shadow banking sytem cannot be offset by fixing the banks and that in reality we haven’t fixed anything yet, just added a band-aid to a gaping wound.
Damien: So, there’s been a swap of providing credit?
Josh: Right. Commercial and savings institutions were 54% of total non-revolving consumer debt in 1989, and then only provided 30-34% since 2002. I bring it up because even if we make our banks whole, even if we plug the holes in their balance sheets, provide them capital or force them to raise capital, create new demand for borrowings, and create a steep yield curve, the reality is we’ve lost the system by which we funded a trillion dollars of collateral in this economy in 2007. And that’s 2007 alone.
What have we done to fix the issue? We haven’t fixed either the banks nor have we fixed the credit markets. Fixing would actually be a fundamental repair — not a patch like we have now. We’ve put up scaffolding to make sure when bricks fall off the buildings they do not hit people below. In our case, the scaffolding has names like Commercial Paper Program, TALF, PPIP, the TGLP, and quantitative easing.
Wait, Congressmen aren’t bound by insider trading laws? Hat tip to Zero Hedge and the CPA blog for posting the link to this transcript from NPR. I attribute my ignorance of the facts in this case to my relative newness to the investment management world. I had no idea that Congressman do not have to abide by insider trading laws. This is unbelievable to me. Talk about the ultimate insiders. They get to talk to Federal Reserve and Treasury leaders who shape our entire economy and can push asset prices up or down based on tiny decisions. Thus, foreknowledge of these decisions could potentially lead to incredible investment opportunities. Of course, during the crisis last year a few people apparently took advantage of their superior information:
STEVE HENN: A year ago this week Treasury Secretary Hank Paulson and Fed Chairman Ben Bernanke dashed to Capitol Hill. They hastily met with a small group of congressional leaders to tell them that the country was teetering on the edge of financial catastrophe.
Paulson and Bernanke asked Congress to spend hundreds of billions to save the banks…
The next day, according to personal financial disclosures, [Representative] Boehner cashed out of a fund designed to profit from inflation. Since he sold, it's lost more than half its value.
Sen. Dick Durbin, an Illinois Democrat, who was also at that meeting sold more than $40,000 in mutual funds and reinvested it all with Warren Buffett.
ALAN Ziobrowski: Senators make significant abnormal returns, some place around 1 percent above the market, 12 percent a year.
Alan Ziobrowski is a business professor at Georgia State University. Using hundreds of personal financial disclosures from the 1990s, Ziobrowski analyzed more than 6000 stock transactions by members of Congress going back up to 15 years.
Ziobrowski: We have every reason to believe they are trading on information that the rest of us don't have.
Craig Holman is at Public Citizen, a consumer watchdog. Holman believes lobbyists shouldn't be allowed to sell tips to hedge funds and members of Congress shouldn't trade on non-public information. But right now it's legal.
HOLMAN: It's absolutely incredible, but the Securities and Exchange Act does not apply to members of Congress, congressional staff or even lobbyists.
Consistent abnormal returns--if this is not smoking gun evidence of legal corruption I am not sure what is. I would love to know what the original rational was for exempting member of Congress from these rules. Just think for a second about the potential conflicts of interest here. How could you know that a lawmaker was not voting his book, meaning that he or she voted for legislation that would benefit his/her financial position? Also, how can we be sure that a Congressperson would put his or her constituents before profit motive? I understand that these conflicts are inherent to the position but they are exacerbated by the fact that these people can legally trade on non-public information. Luckily, there may be some reform on the horizon. A bill called the STOCK Act is being circulated that would remove the exemption. For anyone looking for a new cause to take up, this might be a very worthwhile one.
Ugh, PPIP rears its ugly head: Let me just say it. I never liked the PPIP. I always thought it left the taxpayer on the hook for potential losses and let private investment vehicles keep far too much upside for the amount of equity they put in. But now we have our first PPIP deal as discussed by the Rortybomb blog. From the NY Times article posted by Mike Conczal:
Agency officials said the deal meant that investors would be paying about 70 cents on the dollar for the loan portfolio…Had the government not provided Residential Credit with the ability to borrow most of the money it needed at low interest rates, agency officials said, the investors would have probably paid about 20 cents on the dollar less than they did.
So the leverage allowed the investors to pay 70 cents on the dollar instead of 50 cents. That would indicate to me that the assets were actually worth closer to 50 cents but as predicted, the structure of the PPIP inflates asset prices. This is exactly what we need. More distortion of the fair value of assets. Here are Mike’s comments:
So private investors have come in with $64m, to get a 50% stake in a company that purchases $1.3bn in mortgages. The Treasury provides the other $64m, while the FDIC provides 6-to-1 leverage to purchase this. The actual bid on the loan is $727m…
Residential Credit puts up $64m, on a $727m bid for $1,300m in assets. If the assets are worth less than $727-$64 = $663m, then every additional dollar comes from me and you, the taxpayer. If the assets are worth more than $727m, then we split the earnings with Residential Credit.
So for small price of $64m, or about 8% of the bid, they get half the upside gains while only absorbing a bit of the downside loses. We are also on the hook for a lot of interest rate risk, which I’m not going to bother to quantify. This is a terrible deal…
My sentiments exactly. Taxpayer takes the majority of the downside and can only receive 50% of the upside. This is what we call an asymmetric return profile. Great for Residential Credit. Horrible for you and me. By the way, these assets were from a FAILED bank. So the taxpayer just took on all the downside risk without the associated benefit of unclogging an existing bank's balance sheet so it can lend. What was this supposed to accomplish again?
The way to stop climate protection reforms is by lying to the American people: Or, at least that’s the tactic that Paul Krugman claims the Republicans and those who oppose such reforms have sunk to. In fact, contrary to all of the commentary that suggests that the US economy would be doomed if Congress passed laws to reduce our impact on the earth, the CBO apparently believes the costs would be minimal:
Earlier this month, the Congressional Budget Office released an analysis of the effects of Waxman-Markey, concluding that in 2020 the bill would cost the average family only $160 a year, or 0.2 percent of income. That’s roughly the cost of a postage stamp a day.
By 2050, when the emissions limit would be much tighter, the burden would rise to 1.2 percent of income. But the budget office also predicts that real G.D.P. will be about two-and-a-half times larger in 2050 than it is today, so that G.D.P. per person will rise by about 80 percent. The cost of climate protection would barely make a dent in that growth. And all of this, of course, ignores the benefits of limiting global warming.
So where do the apocalyptic warnings about the cost of climate-change policy come from?
Are the opponents of cap-and-trade relying on different studies that reach fundamentally different conclusions? No, not really. It’s true that last spring the Heritage Foundation put out a report claiming that Waxman-Markey would lead to huge job losses, but the study seems to have been so obviously absurd that I’ve hardly seen anyone cite it.
Instead, the campaign against saving the planet rests mainly on lies.
Krugman suggests that opponents of climate protection are using the same scare tactics that people who are against health care reform are using. The Democrats are going to kill grandma! Any taxes on carbon emissions are going to make the US uncompetitive and destroy our standard of living! Now, I have no idea how accurate the CBO’s or any other estimates are. But trying to drum up opposition through ludicrous assertions is pretty despicable in my eyes. Why can’t we have thoughtful non-partisan debate about something that could determine our fate as a species? It’s stuff like this that makes me wonder if our political system is beyond repair.
Total borrowing is up, but maybe not as much as you would think: One of the most common arguments among those who believe that the US economy could be in for a nasty fight with deflation is that despite the Treasury’s unabashed borrowing and the Fed’s money printing (sorry quantitative easing), the de-leveraging and credit freeze that is going on elsewhere will likely offset the government’s efforts. Well, now we finally have some data from which we can ascertain which side is “winning:”
This week, the Federal Reserve published its quarterly report on debt levels in the economy. While Uncle Sam borrowed more, others borrowed less…[T]otal domestic debt — the amounts owed by individuals, governments and businesses — climbed just 3.7 percent from the second quarter of 2008 through the second quarter of this year. That is the smallest increase since the Fed started these calculations in the early 1950s…
Until this recession, the idea that American individuals would ever cut their overall debt levels seemed as likely as an August snowfall in Miami. But that was before the bottom fell out of the housing market, something that Florida condo developers had considered to be equally unlikely.
Over the year, total household debt fell by 1.7 percent, and mortgage debt — the largest component of household debt — fell a bit more, at a 1.8 percent pace. This is the 10th recession since the Fed began collecting the numbers, but the first in which the amount of home mortgage debt fell. Some of that decline, of course, came from foreclosures that canceled debt and left lenders with big losses.
It looks as though so far the government’s increased borrowing binge has been larger than the decline in consumer and business indebtedness. But obviously not by much. As mentioned in the article, the 3.7% increase in total debt is the smallest increase since the Fed starting counting. Honestly, this data point really is troubling. If you stop and think for a second about what this means, even without more data you come to the logical assumption that debt was consistently rising faster than GDP during many of the last 60 years. If I saw a business that was piling on debt at a much faster rate than earnings were growing, I would understandably start to worry about that company’s ability to service its debt. Credit growth that stimulates new business creation and GDP growth is certainly necessary for a vibrant economy. However, borrowing that just puts businesses and consumers further into a hole and makes them completely beholden to the banks (maybe that is the point—a person who has such large liabilities may be less likely to speak out or act out against the establishment) creates a pathetic nation of debtors.
Anyway (as I step down off of my soapbox) the most interesting thing to note from above is the miniscule fall in total household debt. With household debt to GDP levels at historic highs and so many people unemployed, you would assume that much more de-leveraging would have occurred during the last year. If economists and investors are concerned about future consumer spending after a 1.7% decline in household debt, wait until these people really start paying down debt as opposed to spending. To fix their balance sheets people are likely going to have to save a lot more, pay down much more debt, and consume substantially less. This is the kind of data that bolsters the deflationists’ arguments and may signal very tough times ahead for US businesses and the economy as a whole. Accordingly, my advice is to beware bearded men who claim that the economy is out of the woods.
(Cartoon courtesy of funnypostcard.com)